13: Financing Options in a Consolidating Market

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Hello, everyone. This is your fearless host, Emmett Scott. And I'm so glad to have you here on another episode of DSO Secrets. So today we're going to take on the big daddy here of DSOs and trying to grow your DSO, which are financing options. You know, this is the question I'm probably getting the. The most around is how do I get the capital necessary to grow? I've got the vision, I've got the people, I'm getting my systems put together, but I don't have the capital. And one of the things I will tell you right out of the gate here is you've got to remember that this is a consolidating market, not a consolidated market. And I know you feel that every day as you're trying to put together your DSO and realize the resources and systems that you don't have yet in place that you're trying to improve. But the rest of the industry, the industries outside that support our industry, are also trying to figure out how to organize themselves to support the DSO growth in the dental industry. And I'll give you a couple examples of that and what the pros, cons and pain points are associated with a consolidating market and how to raise money. And I appreciate everyone who has put some questions on our private Facebook page. Um, so I'm going to try to answer some of those as well in this podcast around financing options and invite all of our listeners who want to join DSO Secrets private Facebook group to. To come join us. All right, so before we dive in, let me give you a little bit of jargon around financing. First off, you got to remember that there's really kind of two options. There's debt and then there's equity options. In a debt financing solution, someone is loaning you money with the idea that they are going to get an interest payment. And there's lots of different varieties around that. The term that you need to remember is oftentimes debt is also called leverage, and we'll talk more about why that's called leverage. But if you think about a lever that by, by bringing in debt, you don't have to give up equity. So in some ways it's allowing you to do more without giving up equity. But a lever can, can move in both directions. Number two option is, is equity. And so if you think about a private equity group or friends and family or other dentists who want to invest and want equity, in that situation, they're not necessarily getting an interest rate on their money, but they're hoping that there will be some kind of exit, some kind of sale in the future at which they will participate and maybe along the way that they will also participate in distributions. So those are your two main options. Are you using debt or are using equity? Are you using leverage or, or using an equity investment? And there are lots of hybrids in between. Sometimes debt lenders will ask for a warrant, which is an equity piece to participate. And then sometimes equity investors, especially private equity investors, are going to ask for their capital to be paid back before any of the equity is distributed. And they may even have an interest rate, a deferred interest rate on that. So we can start getting into a lot of details and intricacies with this, but I think at a top level, it's important to remember that there's either a debt or an equity investor. So let's kind of talk about the ages and stages here. That was one of the questions on the Facebook group is, as I'm growing, what's the right investor for each level of my dso? So the first one that many of you know who already have at least one location is a bank. Now, when you walk into any traditional bank who lends to dentists, you find that even if you're right out of school, if this is your first location, that typically getting that money is fairly simple. In fact, if I partner with a new dentist who wants to open a practice, they can usually get approval within 72 hours to maybe two weeks. It's incredible how the banks have designed themselves around individual dentists being able to get the money to start a practice. Now that's going to be a practice that's going to cost you somewhere between 4 and $500,000. Bank is not prepared to fund you for a practice that's going to be a million dollars. So it's very defined terms. And the reason that banks can move so quickly on even someone who has no experience is because their model is that they are lending to an owner, operator, they have in their underwriting, they know that you as a dentist can work your way out of the loan. In other words, even if things go bad for you and you're not, you know, growing and developing out two or three or 10 locations, that one location, you typically can work hard enough to make sure that their loan payment is being made over the next five to seven years. Now, you may have to take it in the chin on your wage and you may not be able to do everything you had hoped, but they know that their loan can be paid back. And in fact, they know that the default rate is fairly low for individual dentists who want to open up a single practice. Now, if you walk into that same bank having successfully built out a practice, let's say in six months, you took that to the moon, you're doing amazing. And you said, now I want money for a second practice. You loaned to me when I didn't know anything. Now I know everything and I want to do a second practice, they would more than likely say no. And the reason is, is because they again did their underwriting based on your ability to pay them back through your hard work in your hands. And as you start to scale, if they did loan you on that second, it'd be even harder on the third and impossible from there forward. And the reason is because they don't have a way to model out and to know whether you are capable of being a manager. Can you oversee multiple locations? So to answer the first question I probably get the most often is why were banks willing to loan to me when I was right out of school, but now that I'm doing well with my practice, I can't get anyone to help me open up my second, third, and tenth practice. And that is because again, they loaned to you for your ability to work and if you had to lower your wage, but they didn't loan to you because you were a great DSO leader. And most banks just aren't set up to know how to even assess that. So you'll quickly outgrow the banks. And then people say, well, do I need to go to a venture capitalist? Now I think the terminology is, is probably a little off. Venture capitalists tend to give smaller amounts of money to technology and startup growth companies. And we can go into what's probably the venture capitalist for this market. But I'd say for the most part, a true VC firm out of Silicon Valley in California is not going to know how to loan into the dental industry. So what you're more going to see is private equity firms, which, you know, to the layman might feel exactly the same, but private equity firms are looking for groups that already have a couple locations. Ideally, they have some platform and executive team in place and they can be then flavored as either a growth capital where they just want to put in some money, maybe in a minority interest. So they're only going to take 30 or 40% of your DSO and they are going to then give you the capital to open up more locations and grow your platform. Or you can have private equity who are going to take more of a controlling interest, 60% or so, and they're looking to scale the company with you so you can have growth capital, private equity taking more of a minority interest or someone who's taking a majority interest and, and looking to be more involved to scale the company with you. And again, I'm putting things into small boxes here or maybe big boxes. And there's a huge spectrum of different private equity firms. Those who have retail experience, those who have healthcare experience, those who have manufacturing experience, and the different cultures that you find from each of them and their experiences. You have to vet through all of that to see really what's the right fit and what's their vision for you and for the dental industry. I can tell you that many private equity firms want to be in the dental space. They don't all even know what that means, but they want to invest in some platform in dentistry. But they all have their different personalities and capabilities. And so it's up to you to vet that and determine if it's a right fit for what you're giving up versus what you're getting. There's another option called mezzanine debt. So this is like when you went to the bank, except Mesdet is willing to take bigger risks than your local banks or national banks are willing to take. And they're also going to be at a higher interest rate and they'll probably want a little bit of equity as well. So their Equity may be 2%, 7%, 15%, but it will be definitely smaller than private equity. However, of course they expect their capital to be paid back and an interest rate that could be anywhere from 9 to 14%, just depending on what stage you're at. And so those are mes debt. So why would anyone go with someone who's going to charge them that kind of interest rate? Because they want to protect some of their equity and they think that they can use that as leverage in order to grow without having to give up any equity. So those are Kind of your. Your players. I get questions from Dennis. You know, they look at the finance market a lot like laypeople look at dentistry. They just look at it as one big group of people that can do everything around teeth and the jaw. And of course, once you're in the industry, you realize that there are specialties and there's different flavors of people based on what their interests are and what they really do. And the same is true in the finance industry. You really have to find the right fit for you and who will land it at what levels. Now let me kind of dive into where most people end up going in between having done their first practice and then their next stage after that. And that's what I'd call the friends, family and other dentists investors. So this leads to a question we got on the Facebook page of if you know they had a friend who had offered them 200,000 to invest in the DSO, and the question was, what should I do with that 200,000? Where would be the best place to invest that? So, you know, it depends on what stage you're at, but I'm going to assume that this is kind of a startup around one location that has someone bringing in 200,000 and they want to scale from there. My mind goes to invest in another location, use that 200,000 to partner with somebody else. And typically where we're at at this stage, you're going to be partnering with a new dentist who can go and get a bank loan. And then with that 200,000 and with their bank loan and with your expertise, maybe you can set something up where you're a 5050 partner or some, some setup like that. You can listen to my other podcast on partnering and how I think through that. But by having that 200,000 leverage into another location, that by far gives you your best return on investment. With a dollar amount of that level, I think investing in anything else in your DSO, technology, etc. If you've only got one location, it's going to be hard to get your return on investment, even if you develop something that's really awesome because you only have one location to apply that to. So I would think about early investments with friends, family and dentists to figure out how you can slice off a practice and start building out practices with different investors. Now is that complicated? Yes. You have to figure out all of the legal paperwork around non dentists who might want to invest. So you've got to set up a DSO just for that practice. And then your DSO is going to own part of that DSO along with the investor. So maybe we can have a different podcast on how do you set up these sub dsos so that you can have individual investors? I would not early on have a lot of investors in my parent dso. There's an old saying in the entrepreneur industry which is never partner with an architect. And it kind of comes from the idea that if you're building out a big development of apartments, for example, when you first get started, you need an architect. And so there's a temptation to partner with them, believing that they're critical to your continued growth because they're kind of the first need that you have. But the reality is once the architectural drawings are done, there's a lot of other requirements in order to get that development complete completed. So you got to remember early on to only be partnering at your parent company level at your, your primary dso with those you believe that are going to scale with you and can bring value across multiple locations. Otherwise, with individual dentists and other great partners that you want to have, start off by investing in individual locations with them. And then from there, as you scale, then there will be the right private equity partner, mesdep partner, or others that you partner with up at the parent dso. So let me make sure I covered everything around kind of the top level of financing. I think the big thing is to know it's hard. You know, there isn't an easy option. When you walk into the bank and they're telling you no, everyone else has gone through that as well. Some of it might be just finding the right bank. Some of it might be that you're at a stage where banks just don't have a model to lend to you anymore. Then you've got to start exploring the private equity realm. You may want to hire an investment banker who has a Rolodex of private equity groups. They're going to charge a fee. They're like a real estate agent. They go out and find the buyers and sellers. But you may want to run with that and see if that's going to be helpful in scaling. But I think for most people who are at that 1-25-location, you really have to be fairly creative. It's a black hole right now in the industry for financing. You have to look at the friends, family and other dentist to see if you can fill that hole and start to scale up to a place where you feel comfortable bringing in outside investment dollars. And I know there's lots of structure that we could talk about. And again, that's probably another podcast of what's all the structure that would have to be in place to have those financing. But at least in this one, you know, there's banks, there's private equity, there's MES debt, there's friends, family and other dentists. And hopefully this will give you some ideas of where to start. If you have more specific questions, come to the Facebook page on DSO Secrets and hopefully we can get those answered. Until next time, keep smiling. Thank you for listening to DSO Secrets. 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